By Gene Lin
The global economy is going through unprecedented times in 2020. As the pandemic causes wide-scale deglobalisation and rapid decoupling of supply chains, investors are shifting away from vulnerable assets in such volatile times. This period coincides with a renewed momentum of the ESG (environmental, social and corporate governance) movement in the finance space, which calls for asset managers to think critically about investing sustainably rather than focusing just on generating financial returns.
“Integrating ESG into your investment processes and asset allocations will actually give you a better risk-adjusted return,” said Kimberley Stafford, managing director and head of APAC at Pimco in a recent Lynk Speaker Session. “It is not just a question of can I afford to do ESG? But also, more importantly, can I afford not to think about ESG?”
Where did ESG Come From?
The rise of ESG came amid growing skepticism towards the guiding principles of the global finance industry for the past five decades, which prioritised profit above all else. In 2019, Business Roundtable ,a lobbying group composed of America’s most powerful CEOs, famously published an open letter that said delivering value to shareholders should not be corporations’ only goal. In 2020, Larry Fink, CEO of BlackRock, released an annual letter calling business executives to prioritise combating climate change with the implication that companies which do not comply might see their investments being withheld. The net inflow into ESG funds hit US$21 billion in the first half of 2020, according to Morningstar.
“COVID-19 has certainly been an accelerator to that process, bringing issues like social equality, employee safety, healthcare, and supply chain vulnerability, and climate change into sharper focus,” said Stafford, adding that Pimco has seen around US$20 billion investments in ESG related bonds.
During the August Lynk Speaker Session, a survey showed that 42 per cent of the audience considers climate change to be an ESG topic on their radar, whereas 25 per cent of the audience said they are watching the theme of diversity and inclusion among the corporate workforce.
ESG is not without criticisms. While proponents of ESG argue companies that focus purely on generating a return for shareholders risk exposing their assets to unaccounted headwinds such as a pandemic, opponents say it ultimately drives down financial return for asset managers as they voluntarily forego profitable assets just because they do not necessarily meet the ESG principles.
How to Invest in ESG?
According to Stafford, Pimco currently screens investment opportunities based on ESG criteria such as excluding companies that are “tone deaf” to the increasing need for sustainability. For companies that pass the initial test, Pimco uses six major tools to implement ESG practices.
- Bond Issuance: Offer investments to bond issuers in exchange for greater involvement in structuring their projects such that they conform to ESG criteria.
- Company Management: Increase communication with the companies’ management to ensure everyone understands what is expected in terms of meeting the ESG criterion.
- Material Risk: Understand whether the company they invest in has any material risk that might violate ESG standards.
- Sovereign Portfolio: Engage with nation states on how to advance the ESG agenda.
- Climate Target: Demand invested companies to set concrete performance indicators that measure how they address climate change.
- Collaboration: Collaborate with other entities in the finance sector that align with the interest to advance ESG.
Barrier of Entry
Socially conscious investors might encounter two common problems when investing in ESG. The first issue is the lack of a commonly-agreed standard to identify and measure ESG assets in the first place. The second issue is that ESG seems to be an area where only larger firms can afford to enter at the moment.
Currently, ESG is described by many to be an uncharted territory of the investment world. Due to a lack of government regulation or consistent rules to standardise ESG investing, investors often have to decide – on their own – what kind of assets qualify as ESG, and how to measure the quality of an ESG asset once they have acquired it. This environment of uncertainty has incentivised a lot of companies to roll out ESG products that some argue are more cosmetic than substantive in nature.
Until investment firms have a standardised framework in ESG investing, smaller players are likely to be left out of the space since the resources required to make investment decisions in such an uncertain market would be too high. Moreover, since smaller players still need to generate financial returns regularly, they might eventually see ESG investment as a luxury they cannot afford.
While Stafford said ESG assets are much more resilient compared to those that are not, she also acknowledged that ESG investors should have a “long-term horizon” in terms of seeing their returns since ESG is not insulated from market events.
“We cannot ignore ESG, it is here to stay,” said Stafford, “there are a lot of people working on it, and we are all going to evolve together on this in terms of establishing a better framework, more transparency, and clear KPIs so we can measure the impact of our investments”.
The conversation took place in the Lynk Speaker Session titled ‘Invest to Impact: Is ESG Ready to Take Centre Stage in a Post-Pandemic World?’ on August 19, 2020.
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